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Archive | March, 2012

It’s report card time in the investment fund world. Every year at this time, all mutual funds and ETFs are required to file a Management Report of Fund Performance, a document that contains a wealth of useful information. (They’re available from the SEDAR website.) If you’re an index investor, one of the most important things you can learn is a fund’s tracking error.

Tracking error is the difference between the performance of the fund’s underlying index and that of the fund itself. Remember, the goal of an index fund is to deliver the returns of a particular asset class, as measured by an index. If a fund does a consistently poor job of that, it’s time to start looking for another option.

iShares released its MRFPs yesterday, and I looked up the tracking errors for a number of their most popular ETFs:

BlackRock surprised almost everyone in January by announcing that it would be buying Claymore Investments, the second-largest ETF provider in Canada. The move takes another step forward today when the former Claymore ETFs start trading with new names. With a couple of exceptions, all of the Claymore exchange-traded products have been rebranded with the iShares name. The Claymore website has been taken down and all links now take you right to the iShares site.

If you’re an investor who owns any of these ETFs, you should notice the name change when you log in to your brokerage account, but the ticker symbols will remain the same. iShares has also pledged to honour any existing preauthorized cash contributions (PACCs) and distribution reinvestment plans (DRIPs). Claymore pioneered the PACC plans several years ago in an effort to eliminate one advantage that mutual funds still have over ETFs, and both Horizons and XTF Capital have since followed suit.

Whether iShares plans to eventually extend the PACC program to all of its ETFs is one of several unanswered questions. Another surrounds Claymore’s “Advisor Class” ETFs, which charge an additional trailer fee.

One of the problems with actively managed mutual funds is that you can never be sure that the risk level will remain constant. In an income fund with a mix of government bonds, high-yield corporate bonds and dividend-paying stocks, for example, the exposure to these asset classes can vary according to the manager’s whims. Well, it turns out that same is true of some ETFs.

The iShares Diversified Monthly Income Fund (XTR) uses several other iShares ETFs to offer a blend of “income-bearing asset classes, including, but not limited to, common equities, fixed income securities and real estate investment trusts.” The fund’s web page makes it clear that “BlackRock Canada will review, and may adjust, XTR’s strategic asset allocation from time to time, as market conditions change.” However, in practice, the fund’s asset mix has remained virtually unchanged since its launch in August 2010.

But not anymore. XTR recently made a big shift that has significantly changed its risk profile (hat tip to reader Alec P. for pointing this out). Here’s how the fund’s holdings have changed:

Holding
Feb 29
March 22

iShares S&P/TSX 60 (XIU)
15.0%
–

iShares DJ Canada Select Dividend (XDV)
14.6%
5.0%

iShares S&P/TSX Equity Income (XEI)
–
10.0%

iShares S&P/TSX Capped REIT (XRE)
14.5%
8.6%

iShares S&P/TSX Capped Utilities (XUT)
–
9.9%

iShares S&P/TSX North American Prefs (XPF)
11.8%
6.1%

iShares US High Yield Bond (XHY)
9.1%
17.0%

iShares DEX HYBrid Bond (XHB)
8.9%
20.2%

iShares DEX All Corporate Bond (XCB)
8.8%
20.1%

iShares DEX Long Term Bond (XLB)
8.7%
3.0%

iShares DEX All Government Bond (XGB)
8.6%
–

Canadian bonds
35.0%
43.3%

US bonds
9.1%
17.0%

Canadian equities
29.6%
24.9%

REITs
14.5%
8.6%

Preferred stocks
11.8%
6.1%

A major shift

The biggest change is a doubling of the exposure to high-yield bonds (via XHY and XHB),

The details: There are currently 251 stocks in the iShares S&P/TSX Composite (XIC), which is a core holding in my most popular model portfolios. About 73% of XIC (by market capitalization) is concentrated in the largest 60 companies, which can be bought separately with the iShares S&P/TSX 60 (XIU). XMD holds the other 27% of the market, comprising 191 companies. Justin Bender has written a good overview of how these two funds complement each other.

Canada’s large-cap market is absolutely dominated by a small number of companies—mostly banks and energy giants. Just 10 companies make up a third of this country’s market (and half of the S&P/TSX 60).

Spring is a time for renewal, so I am happy to announce that I have freshened up some of the permanent pages on the blog to make them more useful.

When I launched this blog more than two years ago, there were just few dozen Canadian ETFs, so it was practical to catalogue them on a single page. No longer. Today there are more than 300 exchange-traded products on the TSX, with so many being added that it is impossible for me to keep the page up to date.

Moreover, I feel that I can do far more service by helping readers navigate the dizzying array of choices. So the new ETFs page includes a small number of recommendations for each of the major asset classes. I have also included US-listed ETFs among these recommendations, where appropriate.

The situation is different with index mutual funds. The sad truth is that most index funds in Canada are so expensive that they’re not worth recommending to anyone. So my new Index Funds page includes only those that are genuinely useful, as well as some guidance about which fund family may be appropriate for different circumstances.

As I read the post and the comments, it struck me that the two sides were arguing two very different points. In the interest of being a peacemaker, I’d like to frame this debate differently and find some common ground.

Why pick stocks?

Let’s start at the beginning by asking why investors pick individual stocks in the first place. Back in the days of Graham and Dodd, investors had little choice but to analyze and buy individual companies, since there was no way to “buy the market.” That hasn’t been true for a long time, of course. Today, buying the market is easier and less expensive than ever. With equal amounts of the Vanguard Total Stock Market ETF (VTI) and the Vanguard Total International Stock ETF (VXUS), for example,

You’ve got an RRSP with your employer, another with a discount brokerage, and your spouse has a couple of his or her own. You both have TFSAs, too, plus an online savings account where you park your cash. If all of these accounts are intended for the same purpose (such as to fund your retirement), you should think of them as one large portfolio. But how can you keep track of them all?

Q: How do I use the Couch Potato strategy across multiple accounts? We have a taxable investment account, my RRSP, a spousal RRSP and two TFSAs (one for me, and one for my spouse). Should we hold all of the ETFs in each account—which seems cumbersome—or treat them all as one large portfolio? — B.H.

In most cases, you should think of your assets as one large portfolio. If you’re using the Complete Couch Potato, for example, it doesn’t make sense to hold all six ETFs in each of your individual accounts. This just increases trading costs and complexity. However, it is often impossible to avoid at least some overlap when you’re investing across multiple accounts. Here are the important factors you need to consider as you figure out the right plan for your household assets.

The purpose of the accounts. This is the most important consideration: you should only treat your accounts as a single portfolio if they are intended for the same purpose. If you have a group RRSP through your employer and a self-directed RRSP with a discount brokerage, these are both clearly designed to fund your retirement.

“You were in a terrible car accident: you were hit by a bus,” the doctor says gently. “You’ve been in a coma.”

“How long?”

The doctor glances nervously at her colleagues. “A long time, I’m afraid.” She pauses again. “Three years.”

It takes a few seconds for this to sink in. Three years? Your mind is filled with just one urgent question. “I gotta know, Doc. Give it to me straight. How have the markets been doing?”

Again the doctor looks nervously at the rest of the medical team, and they avert their eyes. “I’m sorry,” she says. “It’s been an absolutely terrible time to invest—the worst I’ve ever experienced. Europe is on the verge of collapse. The U.S. government is a financial basket case—it even had its credit rating downgraded.